Church Finances and Business: Should My Church Incorporate? (State law)

A reader asks whether his church should incorporate. Another reader asks whether a refusal to incorporate will protect the church from power plays such as the one describe in this earlier post.

The answer is: yes, a church should unquestionably incorporate, but the church must be very careful about how it does so to avoid creating a conflict between state corporation law and the church’s vision for how the scriptures tell the church to be organized.

Being incorporated is certainly not a violation of the scriptures, but it’s entirely possible to incorporate in a way that violates the scriptures or that’s problematic for other reasons. And not all attorneys are sensitive to the issues that a Church of Christ might struggle with.

Liability

What happens if someone sues an unincorporated church and wins? What if the bank forecloses on an unincorporated church and the building doesn’t sell for enough to satisfy the debt?

It’s hard to say. Here’s why: the law varies from state to state. I’m going to address Alabama law, which is fairly typical of “common law” states, that is, states that inherited their law from England — which is every state other than Louisiana, famous for bignettes, blackened redfish, and the Napoleonic Code. Even though the common law states have a common legal heritage, their interpretations vary and many states have statutes that vary things even more. So check with a local attorney before making a decision. But this discussion will be true of many states other than Alabama.

Now, the common law rule is that a suit against an unincorporated association — a group of people acting together without benefit of incorporation — is that they are “jointly and severally liable.” That means every member is obligated for the entire amount of the debt personally. This is, of course, a horrible thought — if you join a church, you might have just personally guaranteed the bank note and any other liability of the church at all!

Fortunately, there are several exceptions to this rule —

* Insurance. No church should operate without liability insurance! But insurance won’t cover the mortgage. And some policies exclude EPLI coverage, that is, coverage for employment practices, such as sexual harrassment. And all policies exclude liability for environmental claims — and lots of old buildings are chock full of asbestos.

* Unincorporated nonprofit association statutes. Many states have enacted a law changing the common law rule. Most of these laws were passed in the last 20 years or so, and they limit liability to the assets of the association (Alabama Code, chapter 3B of title 10). But not every state has adopted this law.

* Common law exception for churches. Some states have decided that churches aren’t like other unincorporated associations. Rather, the leaders of the church are considered to hold the assets of the church in trust, allowing the church to come under the law of trusts rather than the law of unincorporated associations. This normally limits the liability of the church to church assets and protects the members.

Of course, there are exceptions to the exceptions. If a leader guarantees a bank loan or a line of credit, he’ll be liable regardless of any other consideration. Moreover, if the preacher is guilty of sexual harrassment, he’ll be personally liable for his own actions, even if the church is incorporated. And, of course, as valuable as it is to limit liability to church assets, no one wants to see the bank or a plaintiff force a sale of the church building and seize all the funds of the church.

Borrowing

In most states, a church has to incorporate to borrow money. One reason is that it’s often unclear whether the church has taken all the necessary steps to validly incur debt absent some sort of clear statutory rule. In other words, the bank doesn’t want to get caught in a fight among the members over whether the elders or men’s business meeting had authority to bind the church to the debt.

The common law of most states will vest title to the building in the leaders of the church as trustees for the congregation. This avoids the chaos that would result if each member owned a fraction of the building! But what if the church splits? Or closes? What if there’s a fight over who is in charge? What if a faction argues that the action of the majority violated some scriptural principle? What if the church borrows for a fellowship hall and later the church decides the debt was incurred without authority — that it’s impossible for a church to have authority to build a fellowship hall?

The theory is that incorporation clarifies who is in charge and avoids these fights — but in reality it doesn’t always, as we’ll see. But it helps — if done right.

How to incorporate

General nonprofit corporation act

There are basically two ways to incorporate a church in Alabama. The church can be organized under the general statute for nonprofit corporations (every state has such a law) or the church can be incorporated under the special statute for churches (Alabama Code article 2, chapter 20, title 10A, Section 10A-20-2.01 et seq.) (not every state has such a law). In Alabama, I prefer the special statute for churches.

The general nonprofit statute creates a corporation with a board of directors and members and bylaws. The trouble is that Churches of Christ don’t have a board of directors and we bridle at the thought of having bylaws.That forces us to write down the rules for how to elect officers and directors, all of which is quite foreign to a Church of Christ.

Those Churches of Christ that have incorporated this way tend to run into problems. They often fail to amend the bylaws as their doctrinal understandings shift. What if the church, when incorporated, wouldn’t let women participate in the elder-selection process but now they do? Well, if the bylaws aren’t amended, you have a problem. Someone might argue that the new elders are illegally appointed!

Many Churches have charters (articles or certificates of incorporation) that prohibit instrumental music, prohibit women from certain activities, or impose other doctrinal standards. I’ve always opposed these sorts of things because they are an effort to bind future leaders to a creed. I think the biblical pattern is that the elders presently in office set the doctrinal direction of the church — not the elders who chartered the corporation. Nonetheless, if provisions such as these are the in charter, then the charter may have to be amended before the church can change its practices. And the documents often require the members to vote to amend the charter — taking authority from the elders and vesting it in the members.

There’s a fairly notorious and sad case coming out of the Sixth and Izard Church of Christ in Arkansas. The deacons asked the elders for a copy of the church’s financial records and the elders refused. The deacons ultimately sued, arguing that the church was incorporated under the state’s nonprofit corporation law and the law required that the members be given access to financial records. The Arkansas Supreme Court held that the church has both a spiritual and a legal existence. And the incorporation statute doesn’t govern the spiritual part of the church, including the elders’ authority over such things as church finances. The deacons lost the suit even though state law clearly gave them the right to this information!

This is one decision in one state, but it warns against having documents that say one thing and church leaders that behave in different ways. At the least, it leads to uncertainty. At the worst, it leads to litigation. It’s profoundly important, therefore, that we draft our corporate documents to match how we actually intend to behave. Here are a few points that are often overlooked —

1. Who is a “member”? Under state law, a member of the corporation can vote on many things, but many churches do a poor job of keeping records. Worse yet, the document often don’t define who a member is. The documents should limit “members” to those who are on the church rolls as established by the church leadership.

2. Who can vote? Most state laws presume that any member can vote, but in many churches, voting is limited to adult, male members.

3. What can the members vote on? Generally, you can define in the documents what rights, if any, the members have to vote. You can often eliminate those rights entirely. Can members vote on borrowings? The ordination of elders? A sale of the building? Hiring a preacher? If you don’t say what the answer is, the state law likely gives members the right to vote for “directors” of the corporation, to sell or mortgage the building, and to merge or dissolve.

4. Who are the directors (or “trustees” under some state laws)? The elders should automatically be the directors, appointed however your church appoints elders. But I’ve seen plenty of cases where the charter names the original elders as trustees but no one set up a way to remove or replace them! Sometimes the only named trustees have been dead for years. Sometimes they’ve all left town. Sometimes they led a split.

5. Churches of Christ usually don’t have officers, but a corporation generally is required to have at least a president and secretary. Those should be two of the elders and their office should expire when they cease to elders, but most churches set up the preacher and church secretary — and then forget to change them when they leave.

In short, the corporate/business side of the church should be organized to match the spiritual side, and not the other way around. Define “director” as whoever is from time to time an elder. Modify the default rules to match how you will really do business, and don’t try to make the church act like a corporation. It’s a lot more work for the lawyer, but it’s important that the legal structure not contradict the spiritual working of the church. Oh, and never ever impose your doctrinal understandings on the next generation through legal documents. That’s not scriptural.

Specific church corporation act

Alabama has an ancient statute designed just for churches. And because of the awkwardness of matching the general statute to churches, I almost always use the special statute. You see, it doesn’t have very many rules at all, because it was written by lawyers who understood that churches aren’t governed by corporate law and so shouldn’t have to worry about bylaws and boards of directors and such — unless they want to. And most Churches of Christ don’t want to.

Article 2, chapter 20, title 10A of the Code of Alabama allows a church to incorporate by electing “trustees” and then recording a certificate of incorporation. Now, the trick in a Church of Christ is to specify that the trustee are the elders as from time to time in office. Most churches make the mistake of just naming the original trustees and not specifying how they are removed or replaced. Rather than going into detail, as we in the Churches of Christ tend to be very ad hoc in how we ordain elders, I just say that the trustees are whoever the elders are — and let the church decide how they ordain elders as a spiritual practice not defined by the documents.

The church can then buy and sell real estate and obtain mortgages by following very simple processes laid out in the statute — a majority vote of the membership is generally required. Otherwise, the church operates without regard to the documents — unless it wants to formalize its processes.

Power plays

The way a church avoids having its organization documents used for a power play by an unhappy preacher or disgruntled group of members is to act consistently with the documents — and to draft documents that you are willing to act consistently with.

Key mistakes to avoid —

* Out of date appointments. When you appoint new elders or old elders retire, make sure the state-law trustees or board of directors is updated to match. Make sure the officers are the people you want to be officers. If you don’t do this, the elders may have spiritual authority over the church while a board of trustees appointed 20 years ago has control of the church’s assets!

* Failure to follow the documents. If the documents require new elders to be ordained by the men’s business meeting, then you need to either do that or fix the documents. The courts may or may not enforce those old documents, but who wants to go to court to find out? Update the documents to match current practices.

* Statutory surprises. Sometimes the documents look just fine but state law has been amended or the state nonprofit corporation law creates problems that aren’t evident from the documents. Every so often, pull out the statute that governs your church’s form of organization and see whether there are any problems. Often you can draft documents to change the outcome, but you have to know about the problem to draft around it.

For example, the statute might provide that directors (= elders) are elected by a majority vote of all the members. And yet many churches rarely get enough members present at a business meeting to actually get a majority of the entire membership to vote. Or the law may specify that a majority of the members must attend a meeting to have a quorum, that is, enough members present to take a vote. Many churches would be unable to obtain a quorum. The cure is to change the default rules in the bylaws — but you have to be aware of the problem to know to solve the problem.